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Thursday, October 31, 2013

Fed Vice Chair Janet Yellen has become the fairy godmother of the bull market. When she speaks, stock prices tend to rise, especially since late 2011. She took office for a four-year term on October 4, 2010. Odds are she will be the next Fed Chair. Yellen and I both received our PhDs from Yale and studied under Professor James Tobin. She graduated in 1971. I graduated in 1976. She’s a liberal. I’m a conservative. She is powerful and can move markets. I write about her power to move the stock market higher.

Rich Miller posted a very interesting article today about Yellen and Yale on Bloomberg. He noted, “As a teaching assistant, Yellen was so meticulous in taking notes during Tobin’s macroeconomic class that they ended up as the unofficial textbook for future graduate students.” I studied from those notes. He also refers to a very interesting speech she presented to a reunion of the economics department in April 1999. It was titled, “Yale Economics in Washington,” and is worth reading.

In the speech, she declared that the liberal Keynesian orthodoxy preached by Tobin had conquered Washington. At the time, she was chair of the President’s Council of Economic Advisers, the post held by Tobin during the Kennedy administration. Here, in brief, is the gospel according to Yellen:

(1) “I will try to make the case that the lessons that we learned here at Yale remain the right and relevant ones for improving economic performance, that Yale-trained economists in Washington are succeeding in making their voices heard, and, where Yale economics has been applied, it is working. … I have noticed that Yalies often have a sharper eye for identifying market failures and greater concern for policies to remedy them than economists from institutions I will leave nameless.”

(2) "The Yale macroeconomic paradigm provides clear answers to key questions dividing macroeconomists along with policy prescriptions. Will capitalist economies operate at full employment in the absence of routine intervention? Certainly not. … On the question of whether monetary and fiscal policy can succeed in moving the economy toward full-employment Yale answers yes in both cases except in exceptional circumstances such as a liquidity trap. … Do policymakers have the knowledge and ability to improve macroeconomic outcomes rather than make matters worse? Yes, although there are lags and additive and multiplier uncertainty with which to contend.”

(3) “Although most Americans apparently loathe inflation, Yale economists have argued that a little inflation may be necessary to grease the wheels of the labor market and enable efficiency enhancing changes in relative pay to occur without requiring nominal wage cuts by workers. The attempt to push inflation too low could permanently raise unemployment and reduce the scope for monetary policy.”

(4) “Having described the key elements of the Yale approach to macroeconomics let me go on to claim that the Yale paradigm is alive, well and succeeding in Washington.”

Friday, October 11, 2013

Fed Governor Jerome Powell presented a short speech defending the FOMC today titled, “Communications Challenges and Quantitative Easing.” He noted that the labor market has improved significantly since QE3 was launched in September 2012. He admitted that it is “unclear” how much the program contributed to the progress in the labor market. However, he claimed that “there is evidence that it played a role, lowering long-term interest rates and raising equity prices and home prices, effects that have supported household and business spending.”

In other words, the Fed has succeeded in inflating asset prices, which somehow created more jobs. The market capitalization of the Wilshire 5000 is up $11.3 trillion, or 165%, to a record $18.4 trillion since March 9, 2009. The median existing single-family home price is up 37.3% through August since it bottomed during January 2012. It is just 8.1% below its record high during July 2006.

Housing starts are up from a low of 478,000 units during April 2009 to 891,000 units through August of this year. Yet residential construction jobs are up only 162,000 since they bottomed during January 2011, to 2.1 million in August. They are still 38% below the record high during the spring of 2006. So far, the so-called "wealth effect" hasn't created too many construction jobs.

Powell acknowledged that there has been a failure in communicating Fed policy recently, but mostly blamed it on trigger-happy fixed-income traders, who “began to lose touch with Committee intentions” since Bernanke first hinted at tapering in his May 22 congressional testimony. He said that his decision at the last meeting was a “close call” and that he would have been comfortable with a tiny taper, though he voted against it. He dismissed the notion that the meeting “damaged the Committee's communications strategy.” In his opinion, “market expectations are now better aligned with Committee assessments and intentions.”

Thursday, October 3, 2013

The Fed’s monetary policy has always depended on incoming economic data. It became even more data dependent when the FOMC first formally tied the federal funds rate to the unemployment rate at the December 2012 meeting of the Fed’s policymaking committee. Today, San Francisco FRB President John Williams said, "[C]learly data that's generated by federal government agencies--obviously labor, but also inflation--are key inputs into our thinking about the economy, about our forecast. Obviously, not having that information makes it a little harder to know what's going on." He said so in a Q&A with reporters after presenting a speech titled, “Will Unconventional Monetary Policy Be the New Normal?”

Williams is a nonvoting member of the FOMC, and won’t get to vote until 2015. In his speech, he acknowledged that the Fed’s so-called “unconventional” monetary policies, particularly QE and forward guidance, have become the convention over the past five years. Interestingly, Williams stated that in theory, QE “would have essentially no effect, positive or negative” in a textbook world of perfectly functioning markets.

In reality, he claimed that it can have a positive effect on the economy. More specifically, he noted that numerous studies suggest that “each $100 billion of asset purchases lowers the yield on 10-year Treasury notes by around 3 to 4 basis points.” As for the impact on the economy, he said that the Fed’s $600 billion QE2 purchases might have lowered the unemployment rate by about ¼ percentage point. Wow, that’s a lot of dough for so little bread!

As for forward guidance, Williams admitted, “[C]learly communicating monetary policy and the associated data dependence is simply hard to do well. …Just as good communication can reduce confusion and enhance the effectiveness of monetary policy, poor communication can do the opposite.” He also acknowledged that tying policy to specific data thresholds is “difficult to get right and comes with the risk of oversimplifying and confusing rather than adding clarity.” Finally, he concluded with the following less-than-reassuring thoughts on QE:

Despite all that we’ve learned, the effects of asset purchases are much less well understood and are much more uncertain and harder to predict than for conventional monetary policy. Indeed, the recent outsize movements in bond rates in response to Fed communications about our current asset purchase program illustrate the difficulty in gauging the effects of asset purchases. Moreover, given our limited experience, we can’t be sure of all their consequences, which may play out over many years.

Wednesday, October 2, 2013

In a speech presented 10/2, Boston FRB President Eric S. Rosengren, who is a voting member of the committee this year and among its super-doves, said there were three concerns that argued against tapering. First, the incoming data were “disappointing.” Second, Washington’s fiscal deadlock “might provide a further potential slowdown in economic activity.” Third, bond yields and mortgage rates had jumped to levels that threatened the ability of interest-sensitive sectors to support the economy’s recovery. None of this is new, but his speech confirms and neatly sums up what we knew already.

He also said, “Unfortunately, this [fiscal policy] remains an area of significant uncertainty, given debates in Congress on continuing resolutions and potentially allowing the country to default on its debt. The uncertainties, not to mention the outcomes themselves, threaten to have a collateral impact on the rest of the economy.”

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About: This blog tracks the latest developments in the Federal Reserve System and the other major central banks. It aims to inform the public about global monetary policy. This blog is a companion to The Fed Center website, which provides an extensive updated library and archive of related resources.